CHAPTER 7:

Income from Property

Prepared by

Kristie Dewald
University of Alberta
Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Education Limited

I. Income from Property

I. Income from Property Defined
II. General Rules for Determining Property
Income
III. The Unique Features of Property Income
IV. Impact on Investment Decisions

I. Income from Property Defined

Return on invested capital where:
little or no time, labour or attention has been expended.

Includes the following:

1. Dividends - on capital shares of corporations
2. Interest loans, deposits etc
3. Rental income real estate or other tangible
property
4. Royalties patents, mineral rights, etc.

I. Income from Property Defined

Property income is the annual or regular return received
for allowing another party to use ones property.
Does not include capital gain or loss.

Capital
Gain
Or Loss
4

II. General Rules for Determining Property

Income
Property income = profit therefrom.
Reflects the net concept:
Property revenues
less
Related expenses

II. General Rules for Determining Property

Income
Expenses incurred to earn property income are deductible
if:
a) Incurred to earn taxable property income;
b) Not capital in nature;
c) Not a reserve;
d) Not a personal or living expense; and,
e) Are reasonable under the circumstances.

A. Property Income and the Taxation Year

Property income is determined annually

Individuals:
Coincide with Calendar year.

Corporations:
Coincide with fiscal period.

B. The Deduction of Interest Expense

Deductible if loan was incurred to purchase investments
to earn property income.
Loan documentation:
Must establish purpose of loan:
Maintain separate accounts.

Principles for Maximizing

After-tax Cash Flows
1. Use excess cash to purchase personal assets.
2. Use borrowed funds to purchase investment assets
maintain clear records.
3. Use excess cash to pay down personal debt first.

Interest paid on personal loans is not deductible.

Principles for Maximizing

After-tax Cash Flows
Consider an individual who borrows $10,000 at 10% to
purchase either a Cottage or an investment. Individual
has a tax rate of 45%.

Cottage personal use

Loan
$10,000
Interest paid
1,000
Tax saving
0
Cost of loan
after-tax
1,000

Investments
Loan
$10,000
Interest paid
1,000
Tax saving
(450)
Cost of loan
after-tax
550
10

III. The Unique Features of Property Income

A. Interest Income

Interest income definition the compensation received

for the use of borrowed funds.

Corporations recognize on an accrual basis

Include as income on a daily basis,

even though not received or receivable until some future
time.

11

A. Interest Income
Individuals have three options:
1. The receivable method
2. The cash method
3. The anniversary day accrual method

12

A. Interest Income
Individuals may use the receivable method or the cash
method subject to the rules of the anniversary day
accrual method
Method chosen must be consistently used for that
investment.
Receivable method:
included in income when the amount is legally due and
payable.

13

A. Interest Income - Individuals

Cash method:
Included in income in the year received.

Anniversary Day Accrual Method:

Supplementary rule even though may choose either the cash
or the receivable method
Requires that interest income be recognized for every 12month period from the date the investment was made
Means interest can only be deferred for limited period.

14

Annual Accrual Method

Loans $100,000 on February 1, 20X1. Loan must be repaid
in two years. Interest is charged at 12%, compounded
annually and is payable at the end of two years.

Cash Method
Year
Income
1
0
2
0
3
$25,440
Total
$25,440

Required
method so
cannot
defer for
long
periods

Annual Accrual Method

Year
Income
1
0
2
$12,000
3
$13,440
Total
$25,440

15

Foreign Interest
Interest earned recognized in Canadian dollars.
Gross amount is included:
Amount received plus foreign taxes withheld.

If foreign tax is withheld may receive a foreign tax credit

Reduces Canadian taxes, if applicable.

16

Deductions from Interest Income

Interest expense on loans to acquire interest bearing
investments
Investment counselling fees
Costs incurred to obtain a loan - 1/5 per year
Investment management fees.
Fees paid to a financial institution to hold
securities.
Accounting fees.
Reserves for uncollectibles where interest income has
been accrued

17

Deductions from Interest Income

A loss from property can offset other sources of income.

Expenses

>

Property
Income

18

B. Dividend Income
Dividends the returns provided on the investment in
shares of a corporation
Dividend income can be received by both individuals and
corporations.

19

Dividend Income
Corporate Ownership:
Individual

Individual
Dividend
Dividend

Corporatio
n

Corporatio
n

Dividend

Corporatio
n

20

Dividends Received by Corporations

Included in net income for tax purposes when received.
Dividends received from a taxable Canadian
corporation are deducted when arriving at taxable
income.
In and out calculation.
Result:
Inter-corporate dividends are not taxed.

Removes possibility of multiple taxation.

21

Dividends Received by Corporations

Foreign Corporation Dividends:
only excluded from taxable income if the foreign corporation
qualifies as a foreign affiliate.

A foreign corporation qualifies:

if Canadian corporation owns not less than 10% of foreign
corporation.

22

Dividends Received by Individuals

Dividends from taxable Canadian corporate shares are
included when received.
Grossed Up:
Received from Private Corporations:
117% (2016) - if eligible for special low-tax rates - Non-Eligible
dividends. Gross up decreases gradually from 2016 to 2019.
138% - if not eligible for special low-tax rates Eligible dividends.

Received from Public Corporations:

138% - Eligible Dividends

A dividend tax credit (DTC) is available Chapter 10.

23

Eligible Dividends Received by Individuals

Corporation
Income
$1000
Tax @ 27.5%
(275)
Net earnings
$ 725

Individual Shareholder:
Dividend from Corporation
$ 725
Taxable dividend ($725 x 1.38)
$1,000
Tax @ 45%
450
less DTC
(275)
Net personal tax
$175
Total tax paid on Corporate profits
Paid by corporation
$ 275
Paid by individual
175
$450
24

Dividends Received by Individuals

Changes
from 20162019

Corporation
Income
$1,000
Tax @ 14.5%
(145)
Net earnings
$ 855

Individual Shareholder:
Dividend from Corporation
$ 855
Taxable dividend ($855 x 1.17)
$1,000
Tax @ 45%
450
less DTC
(150)
Net personal tax
$300
Total tax paid on Corporate profits
Paid by corporation
$ 150
Paid by individual
300
$450
25

Dividends Received by Individuals

Dividends from foreign corporations:
Not subject to the gross-up and
Dividend tax credit treatment.
Actual amount of dividends (before withholding taxes) is
included in income in the year received.

26

Stock Dividends
Stock dividends corporation issues additional shares in
lieu of a cash dividend
Deemed to be a taxable dividend;
Individuals dividend is subject to gross-up and DTC.

27

C. Rental Income
Compensation received for allowing another party to use
ones property.
Included on accrual basis:
When earn
Regardless of when received.

Early payments of rent can delay recognition until

earned
Rental Income = Rent Expenses
28

Deductions from Rental Income

Costs incurred to obtain
loan financing
Insurance
Property taxes
Repairs
Maintenance costs
Utility costs
Advertising

Landscaping costs
around a building
CCA
Salaries and wages
Property management
fees
Accounting costs
Costs incurred to
collect rents
29

Special Rules for Capital Cost Allowance

Two special rules - apply only to rental property:
1. CCA claimed on rental properties cannot:
Create a rental loss, or
Increase a rental loss.

2. Separate classes for each rental building costing

$50,000 or more.
No pooling of rental property =/> $50,000.
Means when sold will always trigger recapture or

terminal loss
- Even when new building is acquired in same year.

30

D. Royalty income
Normally treated as property income
Usually require little if any effort to achieve revenue

Can be considered business income if considerable effort

is made to earn the income
I.e. musicians, authors etc.

31

IV.

Impact on Investment Decisions

A. Cash Flow and Return on Investment

Interest-bearing securities:
-

Timing of tax payment may not coincide with cash

received.

Investment in corporate shares:

Dividends, and/or
Growth in value (taxation discussed in Chapter 8)

Real Estate Investments:

CCA deductions, and

Recapture

The ultimate after-tax yields vary considerably.

Must examine relative risk and expected returns of
each alternative investment.
32

IV.

Impact on Investment Decisions

B. Business Organization Structure:

Separating appreciating assets

-

Provides protection from business failure,

Separate fortuitous gains from profits,
May accelerate recapture due to separate class
requirements for rental property.

33

IV.

Impact on Investment Decisions

C. Corporate Financing

Debt versus Equity financing:

-

Understanding varying tax treatments of property

income on investors rate of return.

Corporate financing Chapter 21

34

IV.

Impact on Investment Decisions

D. Splitting Property Income among Family members

Attribution Rules

Tax rates vary among family members

Attempts to lower overall family taxes paid by investing
family savings with lower income individual
Anti-Avoidance Rules property income included in income
of the taxpayer who created the wealth

Not limited to property income.

35